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A System Dynamics Model of Ukraine's Monetary Sector
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Kyiv, Ukraine
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Abstract
This paper presents a system dynamics model of the monetary sector of the Ukrainian economy. It
is one of the products of a project for developing system dynamics modeling capacity among
economists at the National University of “Kyiv-Mohyla Academy”, organized by the University of
Bergen and funded by the Norwegian Center for International Cooperation in Education. Prepared
by a PhD student from Kiev, the monetary sector is a sub-model of a comprehensive macroeconomic
model being developed by a team of Ukrainian students taking a special topics course in
macroeconomic dynamics in Bergen.
Keywords: macroeconomics, MacroLab, monetary policy, Ukraine
Introduction
The project between University of Bergen and University of “Kyiv-Mohyla
Academy” is aimed to develop a system dynamics macroeconomic model of
Ukraine. Using the model developed by D. Wheat for the US economy called
MacroLab as a base (Wheat, 2007), students work on separate sectors of Ukrainian
economy and connect them into a big model. MacroLab presents general
relationships within the economy of the country including a set of separate models:
production, income distribution, consumption, government, monetary, price,
exchange rate, international trade.
This paper presents current results of Ukrainian monetary sector modeling.
The purpose of the model is to investigate and explain the process of creating money
in Ukraine and to illustrate the relationship of monetary policy and general
macroeconomic equilibrium. Comparing to MacroLab, which in most cases reflects
economic relationships inherent to the US economy, the monetary policy on
regulating the money supply in the system is much different in Ukraine. MacroLab
illustrates the policy of interest rate targeting conducted by the Federal Reserve
System. In order to keep inflation and employment on the desired level, the FED
determines the Target Fed Fund Rate. Using open market operations by buying or
selling bonds, the FED influences reserves supply which, in turn, has an effect on
interest rates. Lower interest rates stimulate demand for loans increasing the supply
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of money in economy, and vice versa. For a long time, this was a useful policy to
ensure stability and economic growth.
Ukrainian monetary policy is based on the exchange rate targeting in order to
ensure the stability of domestic currency and prices. The National Bank of Ukraine,
being the general monetary policy maker and regulator, determines the target
exchange rate and conducts foreign currency interventions balancing the supply and
demand for foreign currency on the foreign-exchange market. National Bank
(NBU) provides a limited information on its activities. Providing access to
statistical information, central bank is not providing the information on the decision
it makes. Thus, a big challenge is to express the activity of the National Bank in the
model. Nevertheless, having information on the general goals of monetary policy
and central bank’s basic tools of monetary base adjustment, we attempt to develop
a structure that explains the behavior of money supply in Ukraine and represents
decisions of central bank on achieving its goals.
Monetary Transmission Mechanism Model
The basic model of the monetary sector represents the monetary transmission
mechanism that reflects the process of money supply creation in the country. The
structure of the system is constructed by using the aggregate balance sheet approach
presenting assets and liabilities of the banking system excluding central bank.
Assets include stocks of reserves, bonds, and total loans. Deposits, equity, and other
liabilities of banks are added together in liabilities part of the balance sheet. The
balance sheet approach was used in order to keep track of the balance between
assets and liabilities and to represent the way banks manage their portfolios.
Figure 1. The balance sheet of banking sector
The asset portfolio in the simplified model include three stocks that differ by
its liquidity level. Reserves, which include currency on the correspondent accounts
in National Bank of Ukraine, are the most liquid assets. Bonds can be purchased or
sold in the short period. Total loans are the least liquid assets as it takes time for
loans to be repaid. Managing their assets banks firstly determine the level of
reserves that are required by central bank’s regulations. The next step is to
determine the amount of the mid-term liquidity due to the desired liquidity ratio.
The last step is to manage the stock of total loans. If banks have additional resources
3
after satisfying the reserves demand and liquidity ratio, they can increase lending
constrained by the demand for loans. There are three main sources of financial
resources for banks. The first is the equity of banks. Other resources are attracted
in the form of deposits and loans from other banks. Deposits include current
accounts and saving accounts of households, firms, government, and financial
institutions. Banks should also manage their liabilities in order to meet the required
or desired capital adequacy ratio, which is done by changing the stock of Equity.
Different combinations of the main stocks in the model form the monetary
base and money supply. Reserves and Cash together are monetary base – the actual
amount of domestic currency issued by the central bank and put to the financial
system. Deposits and Cash together form money supply (M2) – the amount of
money available in the country.
When banks manage
their balance sheets and invest
their assets to different
instruments, deposits are
created, which increases the
money stock. Figure 2 shows
the causal-loop diagram that
explains the multiplication
process and money supply
formation. To start with,
assume the bank receives
deposit from households in
the form of cash. Received
money from deposit enter the
banking system and become
assets for the bank that can be
Figure 2. Monetary transmission mechanism (CLD – 1)
used for bank activity.
Managing their assets, banks are obliged to reserve the part of the deposit due to
the reserve limit requirements. The rest money are used in the particular model to
purchase bonds and give loans to households and firms. Assuming that money stay
in the domestic financial system and borrowers do not take money in the form of
cash, money from loans are deposited to other banks. Receiving new resources, the
other bank should repeat the procedure of deposit reservation and then it uses the
rest of money for purchasing new bonds or giving new loans if there is no constraint
on demand for loans. In MacroLab for the US economy, the demand for loans is
influenced by interest rates. Interest rate serves as the input to other sectors, such as
capital formation sector and consumption sector, within the big macroeconomic
model. In these sectors, interest rates influence consumption and investments the
part of which form the demand for loans. Theoretically, low interest rates should
increase the demand for loans, and, thus, increase lending and money supply in the
system. Practically, the increase of the demand for loans in Ukraine is mostly
caused due to the inflation. Interest rates on loans are extremely high in Ukraine
4
and their effect is not deeply investigated yet. The causes of the demand on loans
should be discovered in further research. In the particular model, we assume that
all available financial resources of banks for lending are transformed to actual loans
with no constraint on the demand side. The change in demand for lending in the
model would be reflected by the change of desired liquidity ratio. Decreasing the
desired amount of bonds in the portfolio, banks free additional resources for
lending. Moreover, fluctuations of the desired liquidity ratio can be explained by
different perceptions of the financial risks in the system. The higher is the risk, the
higher is the ratio as banks try to avoid additional risk and invest their assets to less
risky instruments, such as state bonds. If financial risks in the system stay
insignificant and demand for loans rises, banks would decrease the desired liquidity
ratio and increase lending to meet the demand. At this stage of the research, before
we investigate the cause and effect relationships between interest rates and lending,
the desired liquidity ratio is taken as exogenous input.
A simple monetary transmission mechanism with the reserve limit ratio of
5% will create money supply that is 20 times higher than monetary base. Two
reinforcing loops (R1 and R2) determine the money multiplication process and two
balancing loops (B1 and B2) take care of the required reserve limit and desired
liquidity ratios. However, the part of money in the financial system is being
withdrawn from banks by households in the form of cash, thus reducing the
multiplier.
Figure
3
shows
additional
causal
relationships
within
the
monetary
transmission
mechanism. Balancing loop
B3, taking into account the
cash to deposit ratio, is
responsible for keeping Cash
stock on its desired level. The
monetary
transmission
mechanism that takes into
account cash withdrawals
with 5% required reserve ratio
and 50% cash to deposit ratio
will create money supply that Figure 3. Monetary transmission mechanism (CLD – 2)
is 2.7 times higher than
monetary base. On the other side, cash to deposit ratio is influenced by interest rates
of banking sector. Theoretically, higher interest rates on deposits attract more
deposits from households and cash to deposit ratio decreases. However, comparing
historical data of cash to deposit ratio and interest rate changes in Ukraine, the
relationship is inverse. Practically, the higher is the interest rate the higher are
withdrawals from the banking sector. The hypothesis is that inflation at the same
time causes the increase of cash withdrawals and interest rate growth. If inflation
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remains low, higher interest rates are more attractive for households to deposit
money. On the other hand, high inflation would encourage cash withdrawals despite
the high interest rates. Moreover, the cash to deposit ratio can be caused by
uncertainties and lack of confidence to the banking system from households. The
representation of endogenous structure for interest rates requires increased attention
in further research and the effect of interest rates in particular model of Ukrainian
banking sector is not presented, while cash to deposit ratio is taken as exogenous
input.
Figure 4 shows the stock and flow diagram of the monetary transmission
mechanism. Assets are presented at the left side of the diagram, while liabilities at
the right side. Trying to keep reserves on the demanded level due to NBU’s
requirements, banks determine the amount of resources for lending. Before giving
new loans, banks manage the stock of bonds due to the desired liquidity ratio.
Available resources that are left after adjusting desired liquid assets are being used
for new lending. Bond purchases are subtracted from indicated lending in order to
avoid the steady state error and keep the reserves stock strictly on its demanded
level. Loans, that are being paid back after one year on average increase the stock
of reserves and can be used for giving new loans. Net lending and bond purchases
stay in financial system and form new deposits that, in turn, are feeding back to the
stock of reserves.
Figure 4. Monetary transmission mechanism. SFD
Managing their liabilities, banks determine the desired capital adequacy
ratio. Assuming that banking system contains all money in the system except of
cash and that all transactions are made using bank accounts, the decision to change
6
equity will affect the stock of deposits. In instance, if banks are willing to increase
equity to the desired level, they usually reinvest their profits or attract new
shareholders. Assuming that profits are received on deposit accounts due to bonds
and loans repayments, and that potential shareholders are keeping their resources in
the form of deposits, the growth of equity will decrease the total amount of deposits
in the banking system. The same process characterizes the change of the other
liabilities stock. On the current stage of research, causes of other liabilities change
are not investigated yet, thus, the change in other liabilities is taken exogenously.
The stock of cash is being adjusted due to the cash to deposit ratio.
Withdrawing money from banks, households decrease reserves of banks that can
cause liquidity problems in banking system. Ukrainian money sector characterizes
by a high share of cash in money supply as most of payments by households are
conducted in cash. Moreover, the amount of cash in the system is sensitive to
inflation in the country. Permanently high inflation provides that households
quickly withdraw money from bank accounts in order to maintain their purchase
ability. Thus, the time to adjust the stock of Cash is shorter than in the MacroLab
(half a year on average in Ukraine).
In order to conduct analysis tests, the model was initialized in equilibrium.
Assume that NBU makes the injection of 50 billion UAH of new money to the
financial system at the three-year point. If the average reserve ratio is 11.5 %, which
is the initial historical ratio in the model, a simple money multiplier theory provides
that money supply will increase by 435 billion UAH. On the other side, due to the
multiplier theory that takes cash in to account, the injection of new money will
create two times higher money supply (estimated historical cash to deposit ratio is
0.73 initially). Figure 5 shows the result of simulation for monetary base and money
supply.
billion UAH
Graph A
Graph B
600
600
500
500
400
400
300
300
200
200
100
100
0
0
0
1
2
3
4
5
6
7
8 0
1
2
3
4
5
6
7
8
Money Supply
Monetary Base
Expected Money Supply
Figure 5. Monetary transmission mechanism test simulation
A – cash drain is ON. B – cash drain is OFF.
Within the transmission mechanism that takes into account cash drain, money
supply increases and overshoots before stabilizing at the new equilibrium level (see
graph A). The reason of that is the counteracting loop that takes care of balancing
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the stock of cash. The increased deposits caused the increase of withdrawals and
money leave the banking sector. The average time to adjust the stock of cash is 0.5
years and households withdraw money that have been already multiplied by
banking sector. The result is the decrease of money supply. If the cash adjustment
loop is not working (see graph B), money supply increases smoothly to the expected
level due to the simple multiplier theory.
The next step is to explain the monetary base adjustment policy of the central
bank, aimed at regulating money supply, and construct the endogenous structure
that reflects the real monetary policy decisions of the major regulator.
Monetary Policy Model
The National Bank of Ukraine, the major monetary policy maker, defines its
main goals. Monetary policy of Ukrainian central bank aims to ensure stable prices
and stable value of domestic currency. These two goals are closely correlated as the
stability of domestic currency, meaning invariable exchange rate, influences the
price level in the country. In order to explain the causal factors that influence the
price level and exchange rate, we developed two simple experimental model
structures. The first model illustrates the structure of price formation. The second
model explains the formation of exchange rate and represents the policy of
exchange rate targeting. These two models will serve as a basis to illustrate the
policy decisions on money supply and monetary base adjustment.
Price level. In order to construct a price model, we define two driving causes
of the price change (Gordon, 1988). The first is the demand-pull effect. Prices
change if the real aggregate demand is higher than amount of produced goods and
services. Due to the General equilibrium theory, higher demand causes the increase
in price. On the other side,
another causal factor of price
change is the cost-push effect
when prices are changed due to
the drop of potential output.
Figure 6 illustrates the
causal-loop diagram of the price
formation. The price level is
presented in the form of index as
a stock with initial value of 1. It
means that the first year serves
as a base year to measure the
price level. The general
macroeconomic
equilibrium
provides that the real aggregate
Figure 6. Causal-loop diagram of price formation
8
demand equals to production. Real aggregate demand can be determined as the
nominal aggregate demand divided by the price level. In other words, prices should
be on the level that allows purchasing of all produced goods and services in the
country. If the nominal aggregate demand increases due to government spending or
consumption, the purchase ability with current prices (potential real aggregate
demand) is higher. This creates the demand-pull effect on prices. Increased prices
lower the purchase ability until the real demand balances with real production.
Thus, the balancing loop B1 exists in order to equilibrate real demand and supply.
On the other side, increased real aggregate demand serves as the impulse for
production. In the big macroeconomic model, real aggregate demand is an input to
Labor and Capital sectors. The higher is the long-run expected demand, the higher
is hiring of workers and investments that form the main production factors – Labor
and Capital. Thus, before prices are adjusted by the balancing loop and the real
demand is higher than real production, GDP increases smoothly.
Another cause of inflation is the cost-push effect. This effect influences the
aggregate supply and occurs due to increased cost of production. Internal causes
appear due to growth of wages and interest rates for loans. External causes appear
due to increased prices on imported goods and services that are used in production.
The change of exchange rate and imported inflation are the first reasons of import
price change. In instance, if the exchange rate increases, meaning the devaluation
of domestic currency, imported goods and services become more expensive for
domestic buyers. The cost-push effect will cause the increase in price level until it
balances with the cost changes. This creates the balancing loop B2.
To illustrate stated relationships we run the experimental model with two
scenarios. The first scenario is the increase of nominal demand by 5% at the threeyear point (the cost-push effect is turned off). The second scenario is the increase
of exchange rate by 20% (the demand-pull effect is turned off). Figure 7 shows the
results of simulations.
billion UAH
Graph A
220
index
1,2
Graph B
1,15
200
1,1
1,05
180
1
0,95
160
0
1
2
3
4
5
6
7
8
0
1
2
3
4
5
6
Nominal Aggregate Demand
Real GDP
Real Aggregate Demand
Price index (right scale)
Figure 7. Price Model Test
A – 5% shock of nominal demand. B – 20% decrease of exchange rate
7
8
9
The increase in nominal demand cause the increase in potential real demand
and creates the pressure on the price level. The price will grow until the real demand
becomes equal to real production. For the period of price adjustment, higher real
demand causes a small increase in production. Second graph shows the simulation
with cost-push effect. Assuming that the weight of imports is 20% of production,
prices should increase by 4%. Producers are now paying higher prices for imported
goods and services. Usually, they shift the production cost growth to consumers by
increasing prices of finished goods. If the central bank does not provide any
adjustments to increase the money supply and, thus, increase the nominal demand,
the purchase ability drops due to increased prices which, in turn, causes a smooth
decrease of production.
The main feature of the price formation in Ukraine is a strong dependence
on foreign trade and capital flows in production process, thus, the cost-push effect
has the biggest pressure on the price level in Ukraine. On the other side, the
demand-pull effect has inconsiderable influence on the price level. This conclusion
can be made by comparing the values of real aggregate demand and real GDP for
the chosen time horizon. For the most time, demand was lower than production.
The only exception was the period before financial crises in 2008 mostly caused by
the decrease of exchange rate. Thus, the exchange rate of domestic currency attracts
the most attention by monetary policy makers in Ukraine.
Exchange rate targeting. Due to the strong dependence of Ukraine to foreign
trade and capital flows, a stable exchange rate is the main goal of the central bank’s
policy. In early 2000s’ the National Bank of Ukraine issued a note that declared a
managed float exchange rate regime. A managed float policy provides that
exchange rate is determined by market forces on the interbank foreign-exchange
open market. Central bank, joining this market, conducts foreign currency
interventions in order to influence demand and supply on the market and avoid
exchange rate volatility. To illustrate the formation of exchange rate we developed
a simple experimental model.
Figure 8 presents the causalloop diagram of exchange rate
formation by market forces. The
supply and demand of currency
can be represented as continuous
inflows and outflows of foreign
currency on the internal market as
the result of foreign trade and
international flows of capital.
Moreover, additional supply or
demand can be created by internal
causes in the form of increased
savings in foreign currency. In the
experimental simple model we
Figure 8. Causal-loop diagram of exchange rate
formation
10
present two main foreign currency flows in Ukraine: currency received from other
countries due to export and currency paid for import to other countries. The export
to import ratio represents the pressure on the exchange rate. The reinforcing loop
R1 is working when currency inflow is different from outflow. At the same time,
exports and imports are influenced by exchange rate. Simply, the higher is the
exchange rate, the more costly are foreign goods to import, and the cheaper are
goods and services to export. This relationship should be presented in the
international trade sector within the big macroeconomic model and feedback to the
exchange rate model. In order to represent the effect of exchange rate on
international flows of currency, in this simple model exchange rate has a smoothed
effect on imports and export (dashed blue lines on CLD). Two counteracting loops
B1 and B2 are responsible for balancing export and import due to changes of
exchange rate.
The key goal of National
Bank of Ukraine is to ensure a
stable and permanent behavior of
exchange rate. For this purpose,
NBU joins the interbank foreignexchange market and uses its
powerful tool of interventions
selling or buying foreign
currency due to imbalances of the
supply and demand on the market
creating an additional flow of
foreign currency. In the model,
the “Target Ex Rate” represents
the value of exchange rate in the
long-run perspective. If export to
Figure 9. Causal-loop diagram of exchange rate
targeting policy
import ratio is different from 1 in
long-run, which is explained by
chronic deficit of balance of payment, central bank changes its target smoothly until
the balance of payment reacts on the new exchange rate. Figure 9 shows the causalloop diagram with exchange rate targeting policy. Balancing loop B3 in this model
determines the value of currency interventions in order to reach the target level. The
higher is the exchange rate from its target level, the greater is the amount of foreign
currency sold by central bank on the open market. Reinforcing loop (R2) determines
the variable target of the exchange rate due to the real flows of currency.
Reinforcing loops R3 and R4 are responsible for activating NBU’s interventions
due to changes in exports and imports. Counteracting loops B4 and B5 work on
balancing imports and exports by influencing the target exchange rate.
In order to test the model, assume a sudden decrease of exports by 10% at the
second-year point. Figure 10 presents the results of simulation. We run the model
with and without targeting policy. If central bank does not join the foreign exchange
market providing a free float policy (see graph A), exchange rate immediately reacts
11
on the decrease of foreign currency supply on the market. At the same time, the
growth of exchange rate affects imports and exports. This effect creates additional
delay in the system causing damped oscillations before stabilizing exchange rate on
the new equilibrium level. The second run with targeting policy (see graph B) shows
that foreign currency interventions are able to avoid volatility of exchange rate and
ensure its smoothed change.
billion UAH
Graph A
205
USD/UAH
billion UAH
1,5
Graph B
1,5
205
0
1,4
1,4
195
195
-20
1,3
-40
1,2
-60
1,1
-80
1
-100
0,9
1,3
185
185
1,2
175
175
1,1
165
165
1
155
0,9
0
1
2
3
4
5
Export
Import
Exchange rate (right scale)
6
7
8
155
0
1
2
3
4
5
6
7
8
Foreign-exchange interventions
Figure 10. Exchange Rate Model Test
A – free float. B – exchange rate targeting
The managed float regime model is usually useful for emerging economies as
it helps to avoid fluctuations in exchange rates on volatile markets. On the other
hand, central bank should use its reserves of foreign currency in order conduct
interventions. This can be very dangerous for the financial system and economy as
the country becomes dependent to foreign loans. Moreover, the R2 loop is usually
broken in such foreign-exchange regime models and central bank defines a fixed
target for exchange rate due to factors that are not based on foreign currency flows.
For the period 2002-2010 Ukrainian central bank frequently conducted currency
interventions in order to fix the exchange rate on the level of 5 UAH per USD. The
financial crisis in 2008 was the cause of rapid decrease in exports and investments
to the country, and, thus, a fast outflow of central bank’s foreign assets. National
Bank of Ukraine devaluated currency by 40% in order to balance foreign currency
flows. The R2 loop of variable target is not working in Ukraine as the central bank
strictly fixes exchange rate or rapidly devaluates domestic currency. Only in some
cases, the National Bank determined the target for exchange rate due to the foreign
currency flows and their potential pressure on the exchange rate.
Monetary base adjustment. As was discussed above, the policy of the
National Bank of Ukraine is based on exchange rate targeting. According to the
“impossible trinity” theory (Obstfeld, 2004), exchange rate targeting policy
together with free flow of capital prevents the central bank of using independent
monetary policy. In other words, the monetary policy of money supply adjustment
of NBU depends on external causes. Due to the assumption that the price level in
Ukraine is mostly caused by cost-push factors, NBU regulates the money supply in
order to keep the purchase ability in the country by using its main monetary tools:
12
open market operations and refinancing of banks in the form of purchase
agreements.
Figure 11 illustrates the
causal-loop
diagram
of
monetary policy of Ukrainian
central bank. The cost-push
effect causes the decrease of real
aggregate demand. According to
the quantitative theory of
money, the amount of money
available in the financial system
equals to the price level
multiplied by the real demand
and divided by money velocity.
Thus, in order to ensure the
ability to purchase goods and
services produced in the country
Figure 11. Causal-loop diagram of money supply
with current prices, NBU
adjustment
determines the required amount
of money, meaning money supply, and required amount of monetary base using
estimations of money multiplier. Injections of new money create money supply
within the monetary transmission mechanism increasing the nominal demand and,
thus, purchase ability. Two reinforcing loops (R1 and R2) are working in order to
overcome the effect of the balancing loop B1 that is activated by cost-push effect.
Simulation results. In order to test the structure of monetary transmission
and monetary policy models and explore whether it reproduces the actual historical
behavior of money supply, we run the model with estimated parameters of cash to
deposit, desired liquidity, and required reserve ratios of Ukrainian banking system
for the period 2002-2010.
billion UAH
700
600
500
400
300
200
100
0
2003
2004
2005
2006
Simulation results
2007
2008
2009
2010
Historical data
Figure 12. Money supply in Ukraine for the period 2002-2010.
Figure 12 portraits the results of simulation where blue curve shows historical
behavior of money supply, while black curve presents simulation results. From
13
2002 money supply increases by more than nine times. This behavior was mostly
caused by injections of new money by central bank. Moreover, the decrease of
required reserve ratio and cash to deposit ratio due to the development of electronic
payments and banking system in general had a positive effect on the money supply
growth. The structure reproduces behavior that fits the data fairly well. However, a
big limitation of the model is the use of exogenous inputs. In the monetary
transmission mechanism, in addition to exogenously estimated ratios, the stock of
other liabilities is changing exogenously. The monetary policy model uses as inputs
exogenous data of domestic production and price level in order to determine the
monetary base adjustment. These are the main fields of interest in further research.
Endogenous structure of monetary transmission mechanism together with
connection to the big macroeconomic model will be used in order to test the effects
of different monetary policies, such as inflation targeting policy.
Conclusions
This paper presents the system dynamics model of Ukrainian monetary sector
as a separate part of the big macroeconomic model of Ukraine within the project
between National University of “Kyiv-Muhyla Academy” in Ukraine and
University of Bergen in Norway. The model includes the monetary transmission
mechanism model and the monetary policy model. Money creation process is
presented using the balance sheet structure where banks manage their assets and
liabilities trying to keep desired levels of reserves, giving loans to households and
firms and buying state bonds providing the process of money supply creation in
economy. National bank of Ukraine is the main institution that conducts monetary
policy and is able to regulate money creation. Due to a strong dependence on
foreign trade and international capital flows, Ukrainian monetary policy is aimed to
keep stable exchange rate of domestic currency in order to ensure price stability.
Thus, the policy of central bank appears in targeting the exchange rate using
currency interventions on the open foreign-exchange market. Exchange rate
targeting prevents the central bank of using independent monetary policy, thus, the
money supply adjustment is conducted in order to keep the purchase ability and
prevent the decline of domestic production due to the changes of production costs.
The simulation showed that model structure generates behavior that fits the data
fairly well. However, on the current step of the research the model includes
exogenous inputs from other sectors, thus, the integration of the model structure to
the main macroeconomic model of Ukraine is required to in order to investigate the
overall effects. The price level and exchange rate models, as well as interest rate
model, require detailed structure in order to represent endogenous relationships
within the big macroeconomic model. Moreover, the interactions of the monetary
sector with consumption, capital, and international trade sectors require additional
attention to these models.
14
The efficiency and feasibility of NBU’s monetary policy of exchange rate
targeting is under big discussion between economist and politicians in Ukraine.
Stabilizing the exchange rate, National Bank is using its foreign reserves in order
to cover the demand on foreign currency damping the pressure on exchange rate. In
order to fill up foreign reserves, National Bank is taking new loans from foreign
governments and international institutions. It appears that such policy is costly and
is not controlling inflation in the country. The topical issue, within the cooperation
with International Monetary Fund and orientation to European integration, is
shifting from exchange rate targeting to inflation targeting, meaning the use of
independent monetary policy of money supply regulation in order to manage
inflation. The system dynamics model of money creation in Ukraine is an important
tool to test the effect of different monetary policies on the banking system and
represent the process of monetary policy implementation.
Moreover, the monetary transmission and monetary policy models within the
big macroeconomic model of Ukraine can be used as a teaching tool in learning
economics to represent economic cause and effect relationships in dynamics.
Implementation of such techniques in the teaching process in National University
of “Kyiv-Mohyla Academy” will be a valuable contribution to education and
science development in Ukraine.
Literature
Levy-Yeyati, E., Sturzenegger, F. (2000). Classifying exchange rate regimes:
Deeds vs. Words, Buenos Aires, Argentina
Mankiw, N. G. (2004). Macroeconomics (7th ed.). New York: Worth Publishers
Obstfeld, M., Shambaugh J.C., Taylor, A. M. (2004). The Trilemma in History:
Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility,
The Review of Economics and Statistics, MIT Press, vol. 87(3), 423-438
Robert J. Gordon (1988). Macroeconomics: Theory and Policy (2nd ed.) Chap. 22.4,
Modern theories of inflation, McGraw-Hill Companies
Sterman, J. D. (2000). Business Dynamics: Systems Thinking and Modeling for
Complex World, MA: McGraw-Hill Companies
Wheat, I. D. (2007). The Feedback Method: A System Dynamics Approach to
Teaching Macroeconomics, PhD dissertation, University of Bergen, Norway
Data source: http://www.bank.gov.ua/
15
APPENDIX
Monetary transmission mechanism and monetary policy equations
Reserves
Reserves additions
net chng in liabilities
Deposits
Making deposits
Bonds
Bonds purchases
Indicated Bonds
desired liquidity ratio
Bonds adj time
Loans
Net lending
Loan repayments
Indicated lending
Reserves Demand
Reserve limit ratio
Cash
net withdrawals
Cash adj time
CD ratio
Equity
Joining equity
Capital adequacy
ratio
Equity adj time
Other Liabilities
Chng in OL
Total Assets
Total Liabilities
Indicated MB
adjustment
Desired monetary
base
Monetary Base
Time to chng MB
Money Multiplier
Desired Money
Supply
Potential real demand
Price Index
Money Velocity
Equations
Reserves(t - dt) + (reserves additions – net lending rate –
bonds purchases) * dt
INIT Reserves = init(Reserves data)
net chng in liabilities + NBU bonds purchases
making deposits - net withdrawals
Deposits(t - dt) + (making deposits – joining equity – net
withdrawals – chng in OL) * dt
INIT Deposits = init(Total Deposits data)
net lending + bonds purchases
Bonds(t - dt) + (bonds purchases – NBU bonds
purchases) * dt
INIT Bonds = init(Bonds data)
(Indicated Bonds-Bonds)/bonds adj time
desired liquidity ratio*Deposits
desired liquidity ratio data
0.04
Loans(t - dt) + (lending rate-loan repayments) * dt
INIT Loans init(Total Loans Data)
lending rate – loan repayments
Loans/5
(Reserves-Reserves Demand)/0.04-bonds purchases +
loan repayments
Deposits*reserve limit ratio
reserve limit ratio data
Cash(t - dt) + (net withdrawals) * dt
INIT Cash = init(Cash data)
(Deposits*CD ratio-Cash)/Cash adj time
0.5
CD ratio data
Equity(t - dt) + (joining equity) * dt
INIT Equity = init(Equity data)
(capital adequacy ratio*Deposits-Equity)/equity adj time
0.3
0.5
Other Liabilities(t - dt) + (chng in OL) * dt
INIT Other Liabilities = init(Other Liabilities data)
Chng in OL data
Reserves + Bonds + Loans
Deposits + Equity + Other Liabilities
(Desired monetary base-Monetary Base)/time to chng
MB
Units
UAH
UAH/y
UAH/y
UAH
UAH/y
UAH
UAH/y
UAH
1/1
years
UAH
UAH/y
UAH/y
UAH
1/1
UAH
UAH/y
years
1/1
UAH
UAH/y
1/1
years
UAH
UAH/y
UAH
UAH
UAH/y
Desired Money Supply/Money Multiplier
UAH
Reserves + Cash
0.25
(1+CD ratio)/(reserve limit ratio + CD ratio)
potential real demand * price Index / money velocity *
desired inflation
Real Aggregate Demand Data
Price data
Money velocity data
UAH
years
1/1
UAH
UAH
1/1
1/year
16
Experimental price model equations
Equations
Price
Chng in price
Indicated Price
Demand-pull effect
Real Aggregate Demand
Nominal Aggregate
Demand
Real GDP
Cost-push effect
Unit production cost
Weight of import in
production
Unit cost of domestic
production
Unit import cost
Imported inflation
Exchange Rate
Price(t - dt) + (chng in price) * dt
INIT Price = 1
(Indicated Price - Price)/0.25
Price*demand-pull effect*cost-push effect
Real Aggregate Demand / Real GDP
Nominal Aggregate Demand / Price
Units
1/1
1/year
1/1
1/1
UAH
225
UAH
SMTH1(Real Aggregate Demand,5)
unit production cost / Price
(1-weight of import in production) * unit cost of
domestic production + weight of import in
production * unit import cost
UAH
1/1
1/1
0.2
1/1
1
1/1
imported inflation * Exchange Rate
1
1
1/1
1/1
1/1
Experimental exchange rate model equations
Equations
Ex Rate
Chng in ex rate
Indicated Ex Rate
Ex rate adj time
ExportImport ratio
Imports
Exports
Target Ex rate
Time to perceive ex rate
Interventions to currency
market
Ex Rate(t - dt) + (chng in ex rate) * dt
INIT Ex Rate = 1
(Indicated Ex Rate – Ex rate)/ex rate adj time
Ex rate/ ExportImport ratio
0.04
(Inwards) / (Outwards + Interventions to currency
market)
smth1(200/Ex rate,0.25)
smth1(200*Ex rate,0.25)
SMTH1((Ex rate/(Export/Import)),time to perceive
ex rate)
3
(Export*(Target Ex rate/Ex rate)-Import)
Units
1/1
1/year
1/1
years
1/1
USD/y
USD/y
1/1
years
USD/y